Asymmetric Cost Behavior and Corporate Environmental Commitments

Abstract

We examine the effect of asymmetric cost behavior (aka “cost stickiness”)—costs falling less for sales decreases than rising for equivalent sales increases—on corporate environmental commitments. Prior research suggests that corporate environmental commitments involve multiyear resource deployments that are difficult to cut proportionally if financial performance declines in the future. Prior literature also documents investors’ negative reactions when firms reduce environmental commitments. Building on these findings, we predict that firms with greater cost stickiness will make lower corporate environmental commitments initially than their peers because they are less capable of sustaining high levels of environmental commitments in the future if sales decrease. Using measures of firms’ environmental commitments based on MD&A disclosures and earnings calls, we find results consistent with our prediction. To mitigate endogeneity concern, we use two quasi-experimental designs that utilize exogenous variations in labor adjustment costs caused by wrongful discharge laws and close-call union elections. These quasi-experimental tests yield results consistent with the OLS results. Cross-sectional analyses provide support for the proposed mechanisms. Furthermore, we show that the firms with greater cost stickiness reduce their real environmental actions, as measured by industrial pollution and green innovations. Our study provides novel insights into the impact of cost behavior on firms’ commitments to environmental initiatives.